Buying Options into Earnings Results Day – Implied Volatility Play

Buying Options just before earnings results are out is the most common phenomena among speculators and traders to gain from a sharp move in the stock. Due to this demand for options & uncertainty surrounding the results, options become expensive during this period due to high implied volatility (IV). Previously, I wrote about how one can take advantage of these high IVs in the stock options in other articles. You can read them here, here & here.

A question from one of the user, in response to above articles, was – “What if we buy call and put option of ATM strike 5-6 days before results and sell a day ahead of results? Options premium would shoot up because of volatility.”  A very valid question and worth exploring. Can we take advantage of increasing IVs in the options going into earning results by buying  options (straddle/strangle) 5-6 days (or more) before & sell a day before results come out?. I don’t know, I’m not sure. Let’s data speak for itself.

Analysis of Buying Options before Earnings Results

Here, I attempt to analyse this question by looking at the recent 2016-2017 Q4 results of major NSE stocks. I have collected data on 26 major stocks which have good liquidity in options to do the analysis. In this analysis, I buy Straddle and Strangle of options of the stocks 15, 10 and 5 days before results and exit a day before the results are out.

Buying Straddles 15 days before results

In the first step of analysis, I bought Straddles (1 ATM call option& 1 ATM put option) of the stock options contracts of the front month expiry at the closing price 15 days before the results day and exit a day before  the results at the closing price. Here is the premium of the straddles over the 15 calendar days (10 market days)

Long Straddle 15 days before the earnings results

The results as depicted in the chart suggests that more straddles end up in losing premium on the day before results than the ones gaining. Out of 26 stocks, premium of 10 stock straddles have gained (a win-rate of 38%) while 16 straddles have lost the premium. Basic analysis suggests that we will more often than not will lose if we simply buy stock straddles 15 days earlier to the results day. But what if we add a filter whereby we buy straddles of those stocks whose implied volatility (IV) is low & therefore cheaper straddles to begin with.

Buying Straddles whose IV Percentile <30

I have added the filter of IV Percentile <30 (indicator for low IVs) to choose stocks whose implied volatility is lower 15 days before the results day. This way we exclude the straddles are higher even 15 days earlier and choose only stock straddles that are cheaper.  The IVP filter has narrowed down the number of stocks to 9 from 26. Here is the chart of premium of stock straddles with IVP <30

Long Straddles with IVP<30, 15 days before the earnings results

The results from the chart shows that 6 out of 9 stock straddles have ended up gaining premium on exit. Simply by adding the IVP <30 filter, the win-rate of  buying stock straddles has improved to 66% from a earlier win-rate of 38% without filter.

Though the win rate has improved vastly by addition of filter, one should be aware that the gain in premium of straddles is not just due to implied volatility but can also be due to steep stock price movement like in the case of CANBK in the above chart.

Buying Strangles 15 days before results

In the second step of analysis, I bought Strangles (One standard-deviation move 1 OTM call option& 1 OTM put option) of the stock options contracts of the front month expiry at the closing price 15 days before the results day and exit a day before  the results at the closing price. The premium of the strangles over the 15 calendar days is depicted in the chart below

Long Strangle 15 days before the earnings results

The results suggests that 10 out of 26 strangles gain premium ( a win-rate of 38%) at exit before results day compared to 15 strangles losing premium and 1 strangle showing no change. Here as well, a plain strangle buying is  a losing proposition. We will see if adding the IVP filter changes the win-rate.

Buying Strangles whose IV Percentile <30

Here as well, I have added a filter of IV Percentile <30 (indicator for low IVs) to choose stocks whose implied volatility is lower and exclude the strangles that are expensive and buy only cheaper strangles.  The IVP filter has narrowed down the number of stocks to 9 from 26. Here is the chart of premium of stock strangles with IVP <30

Long Strangles with IVP<30, 15 days before the earnings results

The results from the chart shows that 6 out of 9 stock strangles gained premium on exit improving the win-rate to 66% from earlier 38%.

Buying Straddles 10 days before results with & without filter

Straddles of the stock options with IV Percentile <30 filter & without filter were bought at closing price 10 days before the results day and exit a day before the results at the closing price. Here is the premium of the straddles over the 10 calendar days

Without Filter

 

With Filter

 

The results indicate that 14 out of 26 stock Straddles ,bought 10 days before the results, gain premium with a win-rate of 53% , marginally above the half-mark.  On the other hand, stock Straddles that were bought with a IV percentile of  less than 30 showed a win-rate of  45% . Both these results indicate that buying straddles 10 days before results day is not fruitful and should be avoided.

 

Buying Strangles 10 days before results with & without filter

Strangles of the stock options were bought at closing price 10 days before the results day and exit a day before the results at the closing price. Here is the premium of the strangles over the 10 calendar days

Without Filter

With Filter IV Percentile <30

Results indicate that buying Strangles 10 days before results show a win-rate of 53%  without filter (14 out of 26 gain premium) and 54% with filter of IV Percentile less than 20 (6 out of 11 gain premium).  Here as well, strangles show a poor win-rate and therefore not a fruitful strategy to follow.

Buying Straddles and Strangles 5 days before results

Though I’m not posting the charts of the results here, the straddles and strangles have performed with even worse win-rate with our without the IV Percentile filter.

Conclusion:

Among all the combinations of Straddles, Strangles, number of days before results  and IV Percentile filter, only stock Strangles bought 15 days before the results whose IV Percentile is less than 30 have shown a meaningful 66% win-rate but with a very small sample size of 9 stocks. The take-away from this exercise is that buying options into the earnings results to take advantage of increasing IVs of the stocks is largely unsuccessful and therefore shouldn’t be attempted. More in-depth study and larger sample size is needed to get more insights into this strategy to improve its win-rate.

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4 Comments

  1. Hi Raghu,

    I also did similar job during this season, My conclusion is more or less similar like you.
    Think, we need to explore this more.

    This strategy works wells for few of the stocks, we need to identify & bucket them separately.

    Have a go at below website:
    https://steadyoptions.com/

    They do similar work for US listed stocks.

    Warm Regards,
    Kaustubh

  2. Here is a problem with this study: You cannot blindly buy xxx days before earnings. Each trade has to be based on the price of the straddle. You buy only when the price is reasonable compared to previous cycle.

    • Hi Kim. You are correct and the author has considered a scenario in which only those stocks are selected where IV Percentile <30 which means that the IV of the stock has been higher on 70% of trading days.

      This means that the straddle/strangle were "cheap" in IV terms compared to the stocks previous history.

  3. Hi,
    In the result of the study above, clearly a part of the picture is missing. The researchers (Mr Raghu) has only considered win rate. Not the win amount. We are speaking about positive mathematical expectancy, whereby even if the win rate may be small, their magnitude of win amount will easily pay for all other losers and still something will be left )

    For example in the study of buying straddles, some of the straddles have made huge money, even if their numbers are very less. This will actually make this type of trading quite profitable actually?

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